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What Should You Do With Google Stock?

Google stock isn't outrageously expensive, but it's overreliant on ads

Yes, yes, I know that the company is now called Alphabet (GOOG, GOOGL). I still think it’s a dumb name because Google became a part of the lexicon, and there’s nothing better for a brand than for your company to become a verb.

new-google-googl-stock-logo-185Setting that monumental mistake aside, I was trying to decide if Google stock (and that’s what I’m calling it, so too bad) might be a growth stock selection for my portfolio going into 2016. I realized I had not checked in on Google stock for awhile, and wondered if I would find something interesting.

I checked, and I didn’t.

First, let me highlight the financials for Google stock, because no matter what comes after, everything returns to these numbers. Google stock is girded by $73 billion in cash and only $2 billion in short-term debt. Google stock has almost $15 billion in free cash flow over the trailing 12 months.

Net income for Google stock increased 21% from $10.7 billion in FY12 to $12.9 billion in FY13, and another 12% to $14.4 billion in FY14. It is on track for about a 10-11% increase this year.

That’s where I hit something “interesting”. I haven’t looked at Google stock in so long that it suddenly went from growth stock to something more approaching a stalwart.

The Trouble With Google Stock’s Valuation

It gets worse, actually. I have been so out of tune with GOOGL that I thought it had its hands in everything. It does, but none of it is actually producing much revenue. In truth, 90% of its revenue is advertising.

That is actually really bad news. Yes, it is a monster in advertising and makes a ton of money doing it. What’s bad is that its revenue stream is not diversified. Advertising is economically sensitive. Now, there are all kinds of advertisers, and some will do better than others in a recession. GOOGL will probably do pretty well because of its reach, and because people will always engage in search.

Still, in a recession, corporate revenue falls, corporate profits fall, and companies cut back on advertising. We saw advertising stocks get hurt pretty badly after the financial crisis. That’s why I don’t really love GOOGL as a possible investment right now.

But Google is doing a lot of other stuff. It’s a quasi-VC company, developing things like driverless cars, and making investments in emerging companies in consumer goods, life science, data, enterprise and robotics. When it comes to portfolio theory like this, most will never go anywhere … except for one that will probably become a blockbuster. It’s almost like a biotech or pharma company experiences.

I suppose this is one way to invest in VC, while at least having a big cash generating core business behind it all.

Except….

At $29 per share in estimated earnings for FY15, and a stock price (minus net cash) of $651, GOOG trades at 22x estimates. That’s not completely unreasonable, but it’s not great, either. For a company growing net income at 12%, plus the 30% premium I give it for having a world-class brand name, free cash flow and cash on hand, I could justify about a P/E of 16.

But do I want to pay 22x for a company with a non-diversified revenue stream and a VC portfolio? It’s a close call.

I don’t think it’s right for me, but it may be right for some aggressive investors who think GOOG will diversify in the coming years.

Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. As of this writing, he did not hold a position in any of the aforementioned securities. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He also is the Manager of the forthcoming Liberty Portfolio. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.

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Article printed from InvestorPlace Media, https://investorplace.com/2015/12/google-stock-valuation/.

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